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3.6 The Nondiscrimination Argument for Free Trade

Learning Objective

  1. Learn how the constraint that trade policies be nondiscriminatory can lead people to choose free trade.

Each person has two roles in an economy: he or she is the maker and seller of some goods or services and the buyer of other goods and services. Most people work in a single industry. That means that each person’s seller interest is rather limited. A steelworker’s industry sells steel. A garment worker’s industry sells clothes. A realtor sells realty services. Although some people may hold several jobs in different industries, most of the time a worker’s income is tied to one particular industry and the products that industry sells. At the same time, most people’s buying interests are quite diverse. Most individuals purchase hundreds of products every week—from food, books, and movies to cellular service, housing, and insurance.

We learned that it is in the best interests of sellers of goods to have as few other sellers of similar products as possible. We also learned that it is in the interests of buyers to have as many sellers of the goods they buy as possible. We can use this information to identify the very best economic situation for an individual with both buyer and seller interests.

Consider a worker in the insurance industry. This worker’s income would be higher the less competition there was in the insurance sector. In the best of all circumstances, this worker’s income would be the highest if his firm were a monopoly. However, as a buyer or consumer, this person would purchase hundreds or thousands of different products over the year. One such product would be clothing. The best situation here would be for all these products to be sold in markets with extensive competition—we might say perfect competition—since this would reduce the prices of the products he buys. Thus a monopoly in your own industry but perfect competition everywhere else is best from the individual’s perspective.

However, consider a worker in the clothing industry. She too would be best served with a monopoly in her own industry and perfect competition everywhere else. But for her, the monopoly would have to be in the clothing sector, while everything else would need to be competitive.

Every country has workers in many different industries. Each one of these workers would be best served with a monopoly in his or her own industry and competition everywhere else. But clearly this is impossible unless the country produces only one good and imports everything else—something that’s highly unlikely. That means there is no way for a government to satisfy everyone’s interests by regulating competition.

However, we could demand that the government implement competition policies to satisfy one simple rule: nondiscrimination. Suppose we demand that the government treat everyone equally. Nondiscrimination rules out the scenarios benefiting individual workers. To allow steel to have a monopoly but to force competition in the clothing industry favors the steelworker at the expense of the clothing worker. The same applies if you allow a monopoly in the clothing industry but force competition in the steel sector.

Nondiscrimination would allow for only two competition policies in the extreme: either regulate so that all industries have a monopoly or regulate so that all industries face perfect competition. In terms of international trade policy, the nondiscriminatory options are either to allow free trade and open competition or to restrict trade equally by imposing tariffs that are so high that they completely restrict imports in every industry.

If people were forced to choose from the set of nondiscriminatory policies only, what would they choose? For every worker, there are plusses and minuses to each outcome. For the steelworker, for example, heavy protectionism would reduce competition in steel and raise his income. However, protectionism would also raise the prices of all the products he buys since competition would be reduced in all those industries as well. In short, protectionism means high income and high prices.

In contrast, free trade would mean the steel industry would face competition and thus steelworkers would get lower wages. However, all the goods the steelworker buys would be sold in more competitive markets and would therefore have lower prices. In short, the free trade scenario means low income and low prices.

So which nondiscriminatory outcome is better for a typical worker: high income and high prices or low income and low prices? Well, the Ricardian model in Chapter 2 "The Ricardian Theory of Comparative Advantage" and other models of trade provide an answer. Those models show that when free trade prevails, countries will tend to specialize in their comparative advantage goods, which will cause an overall increase in production. In other words, free trade promotes economic efficiencyThe extent to which economic resources are transformed into products generating utility to consumers. Efficiency improves whenever greater output occurs per unit of input or when more satisfying consumption bundles are obtained.. There will be more goods and services to be distributed to people under free trade than there would be with no trade. Since the no-trade scenario corresponds to the protectionist choice, this outcome would leave people with fewer goods and services overall.

This means that the high-income and high-price scenario would leave people worse off than the low-income and low-price scenario. If people were well informed about these two outcomes and if they were asked to choose between these two nondiscriminatory policies, it seems reasonable to expect people would choose free trade. It is not hard to explain why a lower income might be tolerable as long as the prices of the hundreds of goods and services you purchase are low. Also, despite having the higher income with protection, what good is that if the prices of all the goods and services you purchase are also much higher?

Of course, there are also some intermediate nondiscriminatory trade policies the government could choose. For example, the government could do what Chile does and set a uniform tariff; Chile’s is 6 percent currently. This would offer the same level of protection, or the same degree of restriction of competition, to all import-competing industries. However, since this would just be intermediate between the overall net benefits of free trade and the benefits of complete protection, the effects will be intermediate as well. Even with these options, then, the best nondiscriminatory choice to make is free trade.

Key Takeaways

  • Nondiscriminatory trade policies involve setting the same tariff on all imported products. The two extreme cases are either zero tariffs (free trade), or prohibitive tariffs (no trade).
  • A free trade policy will cause lower income for each worker but also lower prices for all the goods and services purchased.
  • A protectionist policy will cause higher incomes but also high prices for all the goods and services purchased.
  • Given the choice between high income and high prices or low income and low prices, monopoly concerns suggest the latter would be chosen.

Exercise

  1. Look at an individual country’s bound tariff rates at the World Trade Organization (WTO). These can be found on the country pages of the WTO Web site. Go to http://www.wto.org/english/thewto_e/whatis_e/tif_e/org6_e.htm, click on any country on the page, scroll down to the “Bound Tariffs” link, and click. It will load a PDF file with all the country’s maximum tariffs.

    Choose a country and determine whether the country applies discriminatory trade policies. If it does, identify several products that are highly protected and several that are not protected.